Crude oil is cheaper now than at any time in more than five years. Not surprisingly, some investors are fleeing the energy sector, believing that things can only get worse in the oil patch. Yet for dividend investors, who have traditionally found a haven in the sector -- energy stocks contributed a little more than 12% of the S&P 500's total dividend last year -- a plunging oil price may actually represent an opportunity.
We don't know where oil prices will head in 2015. Predicting the future is always a fool's errand. One thing is certain: Trends, particularly in volatile commodities, can reverse quickly. Some of those now selling oil stocks were among the people buying on July 3, 2008 -- when the spot price of West Texas Intermediate peaked at $145.31. Two days before Christmas in that same year, WTI spot was $30.28, a decline of more than 79% in less than six months as the financial crisis deepened. (Within a year, WTI spot prices were back in the $70-$80 range.)
TIME TO BUY?
Yet applying the old Wall Street adage that investors should "buy straw hats in the winter" seems appropriate for energy stocks now. The S&P 500 energy sector showed a 10% decline in price last year. Energy stocks in the S&P SmallCap 600 plunged 36%.
According to figures from State Street Global Advisors, investors are already scooping up those energy straw hats. U.S. energy sector ETFs attracted $3.4 billion in inflows during December, trailing only the consumer discretionary and financials sectors.
And buying energy funds or stocks that provide dividend income appears to be a prudent way to approach the sector.
For advisors comfortable with rebalancing via individual stocks, two integrated oil companies stand out. Both Exxon Mobil (XOM) and Chevron (CVX) have increased their dividends annually for many years: Exxon has 32 consecutive years of dividend increases, and Chevron isn't far behind with 26 years.
On yield, however, CVX at a recent 4% holds the advantage over XOM at 3%.
As integrated oils, both XOM and CVX can profit no matter what the price of crude. When prices are high, their exploration and production operations benefit; when prices are low, the refining and marketing businesses do best.
For a more diversified approach to the U.S. energy sector, consider the Energy Select Sector SPDR Fund (XLE), the Vanguard Energy ETF (VDE), and the iShares U.S. Energy ETF (IYE).
XLE covers the energy sector of the S&P 500 and consists of 45 large-cap stocks, while VDE (168 stocks) and IYE (95 stocks) contain issues across the capitalization spectrum. All three ETFs are cap-weighted, however, and feature Exxon Mobil and Chevron as their two largest holdings. The two integrated oil majors represent roughly 31% to 36% of each portfolio.
Of course, these portfolios are sector-based, not dividend-focused, and some of the stocks don't pay a dividend. So the overall yield of each fund is less than 2.5% -- not much by historical standards, but still higher than the yield offered by the broader S&P 500 index.
Since these ETFs are "plain vanilla" portfolios of sector stocks, expense ratios are modest, ranging from 0.12% to 0.43%.
The big question for advisors concerns how to balance the risk vs. potential reward of the three portfolios. For example, the Vanguard portfolio holds the broadest array of energy stocks, meaning it holds more of the smaller companies that could face real trouble should oil decline further but are likely to surge when oil prices reverse.
No matter which approach you choose in your rebalancing, energy straw hats are on sale.
- Dividend Investing: New Rules for Real Estate
- When Markets Rage, Do Dividends Help?
- How 6 Dividend ETFs Stack Up